Shorty Fire In AIG

….And that concludes my entire knowledge of HipHop. OK, this song and that Flo Rida remake. And I know there’s someone pronounced “Neo” that has nothing to do with The Matrix.

Anyway, all sorts of chatter on stocktwits yesterday on AIG including several prescient shorting calls. One prob. many faced though was that you couldn’t actually borrow the stock, though that always varies from house to house.

But whenever that happens, I have a suggestion. Use options and simply create your own synthetic short stock.

How do you do that you say?

Simple. You can short calls and buy puts on the same strike and class. Let’s say you short 1 October 45 call and buy 1 October 45 put. It’s effectively identical to the risk/reward of shorting 100 shares of stock.

But here’s the catch. When a stock is difficult to borrow, you will have to short the stock at a discount to the price you see on the board. In the case of AIG, the October synthetics trade for a roughly 50 cent discount to AIG stock. Sounds like a ripoff, no?

Well, it’s really not. If a stock is difficult to borrow, your clearing firm may still let you short it, but you will get hit with interest charges. Those rates may vary, but the discount of the synthetic to the stock itself will reflect that “cost” between now and when the options expire. At least the current cost.

So in other words, even though the option synthetic seems cheaper than the stock, it’s really not. It reflects the market rate of the carrying cost, in addition to a premium reflecting the risk of getting bought in on the short stock.

And here’s another thing. Let’s say you short via the options synthetic at a 50 cent discount. When you cover, you will also be able to cover that same synthetic at a discount to AIG, so you will de facto buy it under AIG’s price anyway.

So why not use the options? Well, the markets are not as tight as they are in the stock. AIG near money’s look about 10 cents wide. And don’t forget you have to slap on 2 sides. In addition, if the stock is difficult or impossible to borrow, you have assignment risk on the calls you short. You can mitigate that risk however by putting on synthetics with OTM calls and ITM puts. In other words, use the 50 line or higher in AIG.


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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